Don’t Cry Over Spilled Milk! a “Plain English” Guide to Retirement Plan Correction Options​

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On April 19, 2019, the IRS updated its guidance on the official methods of correction that can be used by tax qualified[1] and 403(b) retirement plans (and, to a lesser extent, 457 plans). The IRS’ summary of the changes can be found here, and will not be re-summarized in this alert. Instead, we provide a “Plain English” guide to understanding the general options a plan sponsor or administrator has when it discovers an error.


Errors come in all shapes and sizes, but generally must be categorized as “operational failures” and “document failures.” Forgot to update your plan for required IRS amendments? Document failure. Failed to follow an employee’s salary deferral instructions? Operational failure. Implemented one of the many hardship distribution rule changes, but forgot to update the plan document? That could be a little tricky — was it a failure to operate the plan in accordance with its terms or was it a failure to document a plan amendment? When you get into the details of plan correction options, different requirements apply to operational failures and document failures, so this assessment is important.

IRS-Approved Correction Methods

The IRS’ official correction program is called the Employee Plans Compliance Resolution System (EPCRS), which has three sub-categories, known as the “Self-Correction Program” (SCP), the “Voluntary Correction Program” (VCP), and the Audit Closing Agreement Program (Audit CAP). Following is a description of these options, in a nutshell:

  • SCP – this involves correcting the error in accordance with IRS principles, but without notifying the IRS. There are a number of rules that must be satisfied in order to properly use this program. For example, not only must the error be the type that the IRS says can be corrected in this manner, but the correction must generally occur within a certain time frame. In addition, some errors may only be corrected through SCP if the plan has set procedures in place that generally protect against the error, while others are only available if the plan received a favorable determination letter in the past. If that isn’t “plain English” enough, SCP is the equivalent of children cleaning up spilled milk in the exact way their parents told them to, but not telling their parents about the incident. If the IRS finds out about the error later, it is permitted (and expected) to confirm that the correction was appropriate, and should not issue any penalties if it was. In general, a plan sponsor considering SCP should obtain a written analysis confirming it is eligible to correct via SCP, and a copy of that analysis and proof of the correction should be maintained in case the IRS ever investigates the issue
  • VCP – this also involves correcting an error in accordance with IRS principles, but the method of correction is reviewed and formally approved by the IRS. The IRS charges an application fee to conduct this review (currently between $1,500 and $3,500). More errors can be corrected in this manner and the method of correction can be more flexible than with the SCP. If that isn’t “plain English” enough, VCP is the equivalent of children going to their parents to say they spilled milk, explain how they want to clean it up and obtain their parents’ approval in advance. If the plan is audited later, the IRS can confirm that the approved method of correction is used, but should not issue any penalties if it was. A copy of the approval letter from the IRS and proof of correction should be maintained if the plan is ever audited.
  • Audit CAP – this involves correcting an error that the IRS brought to your attention, either through an IRS audit or some other process. It involves correcting the error in accordance with IRS principles and then paying a penalty. The worst-case scenario is that the IRS determines the penalty by assessing the amount of taxes that would be due if all vested plan assets became taxable, and then reducing that amount accordingly. The worst-case scenario rarely arises, but you should expect the penalty to be many times greater than the VCP application fee since the IRS wants to encourage the use of SCP and VCP. If a plan tried to correct via SCP, but did not do so properly, it is subject to Audit CAP penalties, but the penalties will likely be reduced if the plan came close to satisfying Audit CAP. If a plan went through the VCP process, obtained approval for a correction, but did not implement the correction timely, it is also subject to Audit CAP. In the “spilled milk” analogy, Audit CAP is you finding out that your child spilled milk, failed to clean it up properly, and decided not to tell you in the hopes you would not notice. Completing the Audit CAP process will require the plan to be corrected in accordance with IRS principles and the payment of a penalty, after which the plan will receive a “closing letter.” A copy of the closing letter and proof of correction should be maintained if the plan is ever audited.

Non-IRS-Approved Correction Methods

  • A plan sponsor always has the option of doing nothing, and this is normally attractive because it is usually the least expensive option. If the error is discovered by the IRS, then the Audit CAP rules will apply.
  • A plan sponsor or plan administrator may decide to correct the error without notifying the IRS and without confirming that it is eligible for SCP. If the IRS later investigates, we can argue that the correction satisfied SCP requirements, but if the investigation is occurring several years later, it can be harder to conduct that analysis. Ultimately, if the IRS determines the correction did not satisfy SCP requirements, the Audit CAP rules will apply, but the penalty may be discounted if you came close to satisfying SCP. Think of this as your discovering a partially cleaned spot on the floor and when you confront your child, they explain what was done to clean it up. The punishment is likely to be based on how thorough the cleanup was, and how close the cleanup process was to being exactly what you would have advised your child to do if you were told initially.

Depending on the circumstances and the issue, there may be other methods of correction available, but unless it falls within the explicit SCP guidelines or is approved by the IRS through the VCP process, no other form of correction (or non-correction) is automatically entitled to deference during a future IRS audit.

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